Beyond Independent Fund Failures: Correlated Liquidations in Hedge Fund Survival Analysis

Hedge fund liquidations rarely occur in isolation, yet most empirical studies implicitly assume independence across funds. When liquidation risk is correlated through shared liquidity shocks, overlapping exposures, and synchronized investor withdrawals, this assumption can bias hazard model inference. We first use Monte Carlo simulations to show that ignoring correlated time-to-liquidation distorts survival estimates, while incorporating a latent shared factor absorbs common stress and stabilizes inference in the simulated setting. Building on this result, we then propose an implementable proxy for latent dependence using the exposure structure that links Funds of Funds to their underlying hedge funds. The resulting distance ratio proxy measures each Fund of Funds’ relative proximity to resilient and fragile reference profiles derived from underlying hedge fund characteristics. We find that the distance ratio not only explains variation in liquidation risk but also improves out-of-sample risk ranking, increasing the area under the receiver operating characteristic curve from 0.63 to 0.67. Overall, the evidence suggests that explicitly proxying latent structural dependence can materially improve survival inference and risk prioritization in interconnected financial systems.